Unlimited
to the downside of the underlying stock. (May loss more than the amount
of premium collected if you do not have a build in risk management
feature in this option trading strategy)

Maximum Reward

Limited to the amount of premium collected.

Breakeven

Strike price minus premium collected

Net Position

This is a net credit trade because you collect premium from the sale of put option

Advantages and Disadvantages

Advantages:

Time erosion of options values help writer of put option.

May profit from three scenarios: underlying stock price rise, move sideways, or drop by a relatively small amount.

Require less capital than buying the stock outright.

If done correctly, can earn regular income by trading rising or rangebound stock.

Disadvantages

Unlimited risk to the downside of the underlying stock.

Potentially may loss more than the amount of premium collected if the
strike price, expiration dates or underlying stock are badly chosen. You
should only employ this strategy to stock that you wish to own at the
strike price you are willing to pay.

Exiting the Trade

Let the short put options expire worthless and earn the full sum of premium collected

Buy back the put options and close off the position at a profit.

Time decay will erode the value of the option everyday. Assuming all
other variable being equal, option seller (writer) will be able to buy
back the option at a lesser value then what had been paid for initially.

Short Put Options Example

Assumption:
XYZ is trading at $118.50 a share on Mar 20X1. You are expecting share
price of XYZ to rise or move sideway. In this case, you may consider to
sell one Apr 20X1 $115 strike put at $2.20 to profit from the bullish or
neutral outlook of the stock. Note: commissions are NOT taken into account in the calculation.

Selling
a put is one of the simple, short term option trading strategies.
Selling an option does not require you to be precise on the direction,
timing or magnitude of the move and you enjoy the benefit of time decay.
An option writer can also structure the short put in a way to enjoy a
higher statistically probability of success than buying the stock or
buying a put option.

When you short put options, it usually
increases in value due to the drop in the underlying stock price or
increase in volatility. It decreases in value due to time decay, a rise
in underlying stock price or contraction in volatility. Therefore, to
get the maximum return from trading short put options, try to ensure
that the underlying stock is in an upward trend or at least range bound
and also identify a clear area of support. The maximum gain is realized
when the underlying stock is at or above the strike price at expiration
date.

Option is a wasting asset and time decay (in your favor)
accelerates exponentially in the last month before expiration. To get
better trades than buying the stock itself, do ensure that you give
yourself as little time as possible to be wrong. Generally this means
that you should only short options that expire in less than 1 month.

One important point to take note is that if you short a put and is
assigned, you will be forced to buy the underlying stock at the strike
price.

However, some traders considers this as an advantage as
they will be able to own the stock they wish to hold at a price they are
willing to pay.

The premium collected can also lower the cost basis of buying a share.

In order not to buy a stock that is falling, select the strike price around an area of strong support.

Although
this strategy is one of the simple stock option strategies to execute,
shorting a put options (without any risk management features) is a risky
strategy as you are exposed to unlimited losses if the stock price
drop. A single loss from this strategy can wipe out a few years of
profit from shorting option. Most of the brokers will only allow
experience traders to trade this strategy.

You should pick the
strike price and time frame of the put options according to your risk
profile and forecast. Selecting the best strike price at the appropriate
time frame is a balancing act between collecting as much premium as
possible while keeping the risk exposed to the minimum.